Synthesis of the Fiscal and Monetary Policies in Price Level Determination: Evidence from Pakistan

Price stability is one of the key objective of public policy. Ever increasing prices have negative implications for economic growth and poverty. The present study attempts to analyze; how prices in Pakistan are affected by monetary and fiscal policies. It analyzes the interaction of domestic debt, fiscal deficit, money supply and exchange rate with the price level, by applying the VAR decomposition, Granger causality and Impulse response models. The study uses data for the period 1973 to 2010. The results reveal that in Pakistan both Monetary and Fiscal policies play significant role in determination of prices. However, the role of fiscal policy is comparatively stronger than monetary policy as it has both direct and indirect impacts on prices. As the fiscal deficit and domestic debt also affects prices through money supply. Furthermore, the effects of inflationary expectations on prices are highest in magnitude. The study suggests that to cope with increasing prices the coordination between fiscal and monetary policies is necessary.